In the past year the price of Natural Gas on the U.S. futures exchanges has crashed 45% trading between $2.25 and $2.50 per million BTUs, down from a floor price of $4.00.  This crash is the result of a couple of major factors, the first being supply.  The U.S. through horizontal drilling and hydrofracking is producing huge amounts of natural gas.  Production has increased to rapidly that the infrastructure to transport it via pipeline and liquefy it and ship it overseas cannot keep up. 

Between 2006 and 2011 U.S. exports of natural gas have doubled from 724,000 million cubic ft (MMcf) to 1,507,000 MMcf.  95% of those exports go to Canada (62%) and Mexico (33%).  The remaining 4.7% gets liquefied and shipped overseas.  Up until 2009 Japan was the main recipient of our exported LNG, soaking up 99% of it while Mexico bought some scraps.  In the past two years, however, the export market is showing signs of diversification.  In 2011 Japan only accounted for 29% of the LNG export revenues. 

The Great Price Divide

The reason why this is so important to break down is that the price received for LNG overseas is significantly higher than that gained through pipeline sales to Canada and Mexico.  While pipeline gas accounts for 95.3% of the volume it only accounts for 89.1% of the revenue.  In 2011 the average pipeline price received was $4350 per MMcf versus $10500 for LNG shipped overseas.  With the U.S.’s efficient liquefaction technology the best estimates put a $4 premium on the cost of that and transport. 

Through the first two months of 2012, total wet extraction in the U.S. was up 11% over 2011 and dry gas production was up 10% while domestic consumption was down 2%.  Not only does the U.S. have a tremendous revenue opportunity with their abundant and cheap natural gas but in terms of energy costs it’s the closest thing to the economic miracle they’ve been asking for for decades.  

The problem is, of course, politics.  The U.S. Congress wants to keep all of the LNG for itself, having handed out just one permit for a new liquefaction plant to Cheniere Energy (AMEX:LNG) and suspending granting anymore until they decide what should be done.   However, this worry is absolutely premature as the U.S. is not ready to switch over their fleet to natural gas.  With only 120,000 vehicles running on LNG and refueling stations few and far between it would seem the real opportunity lies in exporting surplus production overseas where the arbitrage is enormous.

The average selling price for LNG in Southeast Asia reached $18 per 1000 cf. recently.  If the U.S. can produce it at $2.50 and ship it overseas for even $8 that is a tremendous advantage.  Moreover, countries like Japan and Vietnam cannot satisfy their demand and it is only growing by the day.  PetroVietnam Gas, due to go public in July making it one of the 5 largest companies in Vietnam by market cap, recently decided against building LNG import infrastructure even though current reserves are due to run out in at best 20 years; electing instead to focus on more domestic production.  While smart in the short term because of cost, it will prove to be short-sighted as they will need the foreign supply.

Retrenching and Rebuilding North America

Exxon-Mobil’s (NYSE:XOM) purchase of XTO Energy was an admission by the petroleum giant that so-called unconventional natural gas wells are the future of LNG and dry gas production.  Since they didn’t have the best domestic properties in their portfolio that meant they had to buy some of them.  Energy nationalism, like that expressed by the U.S. Congress, is rising the world over.  Argentina forcibly bought out Repsol’s stake in their state oil company.  Exxon’s move to source domestic supply may also signal that they, who are generally very conservative in where they do business, are expecting it to get harder to do profitable business with various state-owned oil and gas companies.

Conoco-Phillips (NYSE:COP) sold all of their assets in Vietnam, potentially for these reasons, though, of course, they did not say that; noting instead a companywide restructuring of their asset portfolio. 

In what is becoming a recurring theme in this part of the world, Japan is aggressively investing overseas in order to secure itself an adequate supply of energy for the future, especially in light of their now tenuous relationship with nuclear power.  While current Prime Minister Noda has green-lit the restarting of 2 of the country’s nuclear reactors, there is still a tremendous need for more oil and gas imports by Japan.  Inpex, Japan’s largest oil and gas company with a market cap of $18.3 billion US, made a $700 million investment in with Nexen to speed up development of a number of Canadian shale gas projects.  The province of British Columbia has approved, with one of them already in production, three LNG projects.

Royal Dutch Shell (NYSE:RDS), along with Mitsubishi, Korea Gas and Petro-China have begun planning a $12 billion LNG export terminal at Kitimat, B.C. which is the site of at least two other proposed such facilities.  This one would be at least twice the size of the one under construction by a group led by Apache Canada.  British Columbia makes perfect sense, geographically to supply the Pacific Rim as it is a 10 day trip to Japan.

Since Canadian exports to the U.S. have dropped more than 30% in the past five years, it is an imperative for Canadian oil and gas companies to create the infrastructure needed to sell cheap LNG to Asia, where demand can only rise if they are to be the engine of the world’s growth over the next 50 years.